2018 was a down year for most financial portfolios — after nine good years. In addition, volatility, which had been unusually quiet in 2017, came back with a vengeance. The day before Christmas saw the stock market down more than 2% and the day after Christmas the market was up 4%! Now that’s turbulent volatility! Diversification softened the blow a bit but still did not avoid a negative return to a portfolio last year.
Retirees sometimes forget that a “retirement” portfolio is supposed to decline and eventually deplete! The income tax incentives are designed to build a retirement portfolio over several decades. Upon reaching age 70, they are scheduled to fully deplete over 30 years. That is why the government has a Required Minimum Distribution table — to make sure people use their retirement funds.
After a year like 2018, your retirement fund could easily be down 5 – 10%. While this is never pleasant, it does not mean the sky is falling. As I said to a client recently, if you stick with the Requirement Minimum Distribution table you will NEVER run out of money. That does not mean that you will be able to withdraw more every year. If your portfolio declines, then it is very likely the distribution you take this year will be less than last year’s distribution.
Retirees have to make a choice:
- If I want my income distribution from my portfolio to increase every year, then I might run out of money; or
- If I want to preserve future wealth and never run out of money, then my stream of income might be less some years.
Most retirees live off several sources of income:
- Social Security income will increase every year IF the government reports any inflation.
- Pensions typically pay a fixed amount, but some will increase with inflation.
- Interest Income from CDs and bonds are fixed unless the creditor defaults.
- The part of the portfolio that is invested in stocks will have variable income distribution rate. This is the only part of a retiree’s portfolio that offers the potential for significant increases (or decreases) in income.
Every retiree’s financial situation and investment temperament is different. After an erratic year like 2018, you will now be in a position to identify for yourself how much change in income you can financially tolerate or emotionally want.
If the possibility of a decline in your income launches havoc with your blood pressure and rem sleep, then a fixed annuity to fund your income needs is possibly your answer. These have risks as well, and you will not earn what you could in a portfolio of stocks and bonds, but your annual income will be predictable.
If you desire to leave an inheritance to your loved ones, IRAs and 401ks are the LAST accounts you want to give them because they face the highest income tax rates. Now if you want to leave a significant bequest to charity, then IRAs and 401ks are the FIRST accounts you want to leave them because the receiving charity will pay zero income taxes when they access the proceeds.